Discriminatory Related Party Transactions and Corporate Governance Reform: Evidence from Bangladesh A thesis submitted in fulfilment of the requirement for the degree of Doctor of Philosophy Mohammad Tareq MBA (University of Tsukuba, Japan) MBA (University of Dhaka, Bangladesh) BBA (Honours) (University of Dhaka, Bangladesh) School of Accounting RMIT University 2013 DECLARATION I certify that except where due acknowledgement has been made, this thesis is sole done by me and has not been submitted previously, in whole or in part, to qualify for any other academic award. The content of this thesis is the result of research which has been carried out since the official commencement date of my PhD programme. Mohammad Tareq Date: 24.2003 TABLE OF CONTENT Page No. LIST OF TABLES IV LIST OF FIGURES VII ACKNOWLEDGEMENT VIII ABSTRACT IX CHAPTER 1: INTRODUCTION 1.2 Objective and Significance of the Study 4 1.3 Motivation of the Study 6 1.4 Thesis Structure 8 CHAPTER 2: LITERATURE REVIEW: REFORM AND DRPTS 2.2 Corporate Governance Reform 11 2.1 Reform around the World 11 2.2 Reform 2006 in Bangladesh 15 2.3 Background of the Reform 2006 18 2.4 Decoupling in Reform Compliance 19 2.3 Discriminatory Related Party Transactions 24 2.1 Different DRPTs for Private Benefit 24 2.2 Other techniques for private benefits by controlling shareholders 28 2.3 Conditions that Motivate DRPTs 30 2.4 Safeguards for DRPTs in Corporate Governance Reform 33 2.5 Legal system and minority shareholders protection from DRPTs 45 2.6 Legal enforcement and DRPTs 48 2.4 Measurement of DRPTs 52 2.1 Current DRPTs Measures 52 2.2 Limitation of the Current DRPTs Measurements 56 2.5 Conclusion 58 CHAPTER 3: THEORETICAL FRAMEWORK, RESEARCH QUESTIONS AND MODEL SPECIFICATION 3.1 Theoretical Framework for the Research 59 3.2 Development of the Research Questions 66 3.3 Model Specification 69 I CHAPTER 4: METHODOLOGY 4.1Sample selection and source of quantitative data 76 4.2 Methods for Quantitative Data Analysis 77 4.1 Fixed versus Random Effect Estimation Method 77 4.2 Growth Curve Modelling 80 4.3 Measurement of Variables 85 CHAPTER 5: A NEW MEASUREMENT FOR DRPTS 5.2 The New DRPT Measurement Model 88 5.3 Methodology of Empirically Testing the DRPT 91 Measurement Model 5.2 Design of Performance Tests for the New 92 and the existing DRPT Measurement 5.3 Measurement of Variables in the New DRPT Model 95 5.4 Results of the Model’s Performance Tests 97 5.2 Type 1 and Type 2 (power) Error Rates of the Measures 101 5.3 Further evidence: DRPTs Sensitivity on Firms Market 105 Value 5.5 Conclusion 109 CHAPTER 6: FINDINGS: EVALUATION OF THE REFORM 2006 FROM DRPTS PERSPECTIVE 6.2 Quantitative Analysis and Result 112 6.3 Panel Data Regression Analysis 119 6.4 Growth Curve Modelling (GCM) Result 123 6.3 Qualitative Research Finding 125 6.1 Demographic Information on the Interview Participants 125 II 6.2 Independence of Independent Directors in Bangladesh 127 6.3 Audit Committee Competence 129 6.4 DRPTs Approval in Bangladeshi Companies 131 6.5 The Stance of the Board’s Chair 133 6.6 Disparity in Governance among Companies 134 6.7 Improvement in the effectiveness of safeguards 136 CHAPTER 7: CONCLUSION 7.1 Overview and Summary of Findings 139 7.2 Contribution to the Literature 141 7.3 Implications of the Findings 143 7.5 Future research Direction 147 APPENDIX 148 REFERENCES 187 III LIST OF TABLES Page No Table 2.1: Corporate governance reform around the world (2005-2010) 14 Table 2.2: Salient research on decoupling in reform compliance 22 Table 2.3 Summary of salient research on different types of DRPTs 26 Table 2.4: Summary of corporate governance safeguards for DRPTs research 44 Table 2.5 Salient research on legal enforcement and minority shareholders protection 50 Table 2.6 Summary of current DRPT measures 54 Table 3.1: Minority shareholder protection from DRPTs in Bangladeshi law 64 Table 5.1: Sample companies by industry classifications 98 Table 5.2: Summary statistics of the variables 99 Table 5.3: Type 1 and Type 2 error (power) of the new and total RPT based measurement 103 Table 5.4: Type 1 and Type 2 error result of the new and total RPT based measurement for financial companies and non-financial companies 104 Table 5.5: Sensitivity of DRPT on share price: panel data regression results 108 IV Table 6.1: Descriptive statistics of the sample firms 114 Table 6.2: Correlation matrix of variables of the study 118 Table 6.3: Regression results for effect of reform 2006 factors on the level of DRPTs 120 Table 6.4: GCM result for effect of reform 2006 factors on the level of DRPTs 124 Table 6.5: Professional background of participants 126 Table 6.6: Professional background of non-independent directors 126 Table 6.7: Professional background of independent directors 127 Table 6.8: Educational background of independent directors 127 Table 6.9: Audit committee competence 131 V LIST OF FIGURES Page No.1: Control by crossholding of share 31 Figure 2.2: Control by pyramidal ownership 32 Figure 3.1: Description of Williamson’s Market and Hierarchy model applied to the changes in Bangladeshi corporate governance 62 Figure 5.1: Conditions for asset appropriation by related party transactions 89 Figure 5.2: Total RPT and DRPT over the sample period 2002 to 2009 100 Figure 5.3: The new measure of DRPTs and share price: company-by-company plots 106 Figure 5.4: Total RPTs and share price: company-by-company plots 107 Graph 6.1: Board sizes of the sample companies 115 Graph 6.2: Number of independent director in the sample companies 115 VI ACKNOWLEDGEMENTS I would like to express my deep gratitude to my principal supervisor, Professor Dennis Taylor, who has prudently guided and supported me for doing this research.
He has been an unwaveringly dedicated advisor and meticulous reader of the manuscript, without whose encouragement and support, I might never do this work. I would like to express my gratitude to my second supervisor, Professor Clive Morley for his valuable comments and advice on this research. Moreover, I would like to express my gratitude to Professor Sheila Bellamy for her valuable comments on this research. I would like to thank her for giving me encouragement for doing this research.
I also thank all of my fellow doctoral students and staff at the School of Accounting at RMIT University. Finally, I thank my lovely wife, Sejuti and my parent for their encouragement for my study and research. VII ABSTRACT Discriminatory related party transactions (DRPTs) are non-arm’s length transactions with related parties of controlling shareholders for private benefit at the cost of other shareholders. This is a governance issue between controlling shareholders and minority shareholders in both developed and developing countries.
However, most studies on DRPTs are in developed countries with the few exceptions of studies in China, India and Mexico. In 2006, listed companies in Bangladesh were subjected to corporate governance reforms through the SEC/CMRRCD/2006-158/Admin/02-08 order issued by the Securities and Exchange Commission of Bangladesh. The reforms have potential to curb DRPTs. However, prior studies on the effectiveness of corporate governance reform in protecting minority shareholders from DRPTs in a developing country have been limited.
The few evaluations undertaken in China and India have been narrowly focused. Therefore, this area of literature is open to further development. Moreover, there has been limited systematic effort to develop a sound measures for such discriminatory transactions at the company level. One notable measure is the Anti-self Dealing Index which is a comprehensive index to measure DRPTs at the country level.
At the company level, several researchers simply use total dollar amount of RPTs as a proxy for DRPTs. Alternatively, some other researchers use selected RPTs or some derivatives of related party transactions as a measure of DRPT. However, all of these company level measures are based on weak theoretical underpinnings and therefore prone to high measurement error. VIII Considering the limited research on these two related areas of the measurement of DRPTs and the effectiveness of corporate governance reforms in curtailing DRPTs, this thesis develops two objectives.
The first objective is to develop a new improved measure for DRPTs. To achieve the first objective, this thesis develops and tests a measure that seeks to distinguish the proportion of transactions in total RPTs that is discriminatory from the proportion that is based on legitimate business motives. Type 1 and Type 2 error rates and power of the new measurement are compared with an existing measure using computer simulated and real data. The capital market sensitivity of the new measure is also tested and compared with an existing measure.
The new measure is found to be superior to the existing measure. The second objective of the thesis is to investigate the effectiveness of Bangladesh’s 2006 reforms for protecting minority shareholders from DRPTs. For this Oliver Williamson’s Market and Hierarchy model is used as a theoretical framework. Using this framework, several research questions are developed and tested.
A mixed methods approach is used to obtain evidence to address the research questions. Panel data regression modes and growth curve models are run using quantitative data collected from annual reports for a sample of companies and from a publication of the stock exchange. Then semi-structured interviews with directors, independent directors and audit committee members are undertaken and the transcripts are qualitatively analysed. Both the quantitative and qualitative methods identify the limitation and factors that affect the implementation and enforcement of the governance requirements as set out in the 2006 reform for controlling DRPT practices in Bangladesh.
The panel data regression results of the quantitative analysis section show no improvement of the corporate governance variables in IX reducing DRPTs in the post reform period. However, growth curve modelling results shows that independent directors are becoming significantly effective in reducing DRPTs over the post- 2006 period of years under study. The interviews reveal perspectives of key players about flaws in the selection of independent directors and inexperience of independent directors in their role. They reveal that most of the independent audit committee members are either retired bureaucrats or academics.
Many of them frankly acknowledge their deficiencies in accounting knowledge and experience. Moreover, the interviews with directors suggest that many independent directors do not speak out to protect minority shareholders’ interests mainly because of their friendly relationship with the chair or controlling shareholders group who recruited him/her to the board. The results of both the qualitative and quantitative analysis show that a lack of accounting education and experience hinders the audit committee’s activities. The interviews further reveal that independent directors are motivated to learn the job in concern for their social reputation.
This motivation does indicate potential improvement in their performance over coming years. The inference from quantitative and qualitative findings is that independent directors in Bangladesh are currently in learning phase and have the potential to become effective in protecting minority shareholders in the future.1 Introduction Within the last decade, shareholder activism has drawn attention to the plight of minority shareholders who claim to experience behaviour by controlling shareholders that is oppressive, prejudicial and discriminatory. Such behaviour is most notably manifest in discriminatory related party transactions (hereafter DRPTs) that are pursued for the self- interest of the controlling shareholders. 1 The term ‘discriminatory’ is used in the dictionary sense of ‘setting up exceptional treatment against or in favour of particular groups’ (Oxford Dictionary 2013).
The groups to which this term is applied in this study are controlling shareholders and minority shareholders. DRPTs are non-arm’s length transactions by a company with its own controlling shareholders or their associated parties, and have the effect of favouring controlling shareholders at the cost of the minority shareholders. Empirical research confirms that controlling shareholders resort to DRPTs for private benefit at the cost of minority shareholders (Gao and Kling 2008, Cheung et al. 2006, Atanasov 2005, Dow and McGuire 2009, Peng et al.
2010, Dahya et al. DRPTs are found to erode firm value (Peng et al. 2010, Atanasov et al. 2010, Jiang et al.
2010) and many of the notorious 1 Various terms, such as tunnelling, self-dealing transactions, minority shareholder expropriation have been used for such behaviour of controlling shareholders to the minority shareholders. However, no unique term has been used in literature to describe this discriminatory behaviour of controlling shareholders.
